Blog post

A bet on a yet unknown market

Thoughts about the as-a-Service market from an Investors perspective
June 20th, 2022

What relevance does the basic idea (subscribing instead owning) of Netflix have for the classic manufacturing industry, for example mechanical engineering? Many studies and whitepapers already answered this question and the direction of thinking is often a one way road: Asset users want it immediately and producers need to get their heads around a cheap and risk free model to offer. It appears that as-a-Service offerings are the next big trend for industrial manufacturers and the big sales argument in the future.  

Let’s be honest, who is not fascinated by the idea of car sharing, Netflix for machinery or production facilities? In the whole model there is only one particular stakeholder who still needs to get comfortable with as-a-Service and particular about pay-per-use models. Please find below a brief overview of the key discussion items and a non-representative take on the investors or - vernacularly speaking - the “risk-takers” perspective.  

Key Challenge 

As-a-Service models usually have one thing in common: the user pays only when actually using the asset. Without pay-per-use, the whole concept of as-a-Service models gets quite close to classical leasing structures with regard to a single piece of equipment. In the sphere of production facilities without a pay-per-use concept, the as-a-Service model turns out to be rather similar to contract manufacturing1. Thus pay-per-use is really key for the as-a-Service journey.  

By introducing pay-per-use and the ability for the user to only pay when using the asset or production facility, the usage risk (i.e., utilization risk, demand risk) is transferred to the party owning the asset (i.e., contractually offering the service). Usage risk in general is the risk that the asset is not used as originally forecasted or required for an economically sustainable business case. To put it simple: pay-per-use models shift usage risks from the user to the owner of an asset.  

Usage risk in general is the risk that the asset is not used as originally forecasted or required for an economically sustainable business case.

Hence, being the asset owner comes with some hurdles due to the described risk, as well as CapEx requirements and associated balance sheet extensions. One solution is to reallocate risks to third-party investors.  

Investors 

There are many kinds of third-party-investors that come into question for such an investment. One of the main difference between these investors is their investment strategy which implies the willingness to assume risks. In the consideration of taking on risks, two main drivers can be identified: market risk (systemic risk) and venture-specific risk (idiosyncratic risk). While company specific risks can be mitigated (e.g., through technology), systemic risks (such as usage risk) have to be borne by the capital market. Only if this risk is covered by an adequate margin, an investor is willing to provide funding and to engage in the opportunity. In the end it comes down to two factors: (i) can a margin be calculated to price the risk accordingly, and (ii) is such margin paid by the obligor. 

This logic makes one think of venture capitalists. Venture capital is often provided for risks that cannot be priced sufficiently. Nevertheless, venture capital is currently not provided for asset heavy investments  as those opportunities regularly lack scaling opportunities at no or little incremental cost (e.g.,  platform/ software business models). In contrast, venture capital targets investments with above-average return potential, yet significant risks. The main question remains: Can usage risk be calculated in order to define a sufficient risk margin making the investment appealing for investors? 

Understanding risks 

Usage risk is a systemic market risk, which is dependent on economic cycles and hence follows to some extent a random-walk, therefore it is difficult to price. As long as it is challenging to assess usage risk, splitting and distributing risks amongst user, asset producer and investor might be the first step to enter the as-a-Service journey. Key driver is the question of really understanding what is behind and causes usage risk in order to find acceptable structures to transfer each sub-risk to the best owner.  

Sustainably distributing risks can only be achieved by a deep understanding of each risk and its origin. Expertise is needed to holistically asses the whole ecosystem of a production facility. While it seems obvious to most, it is interesting to see that many players in the still early stages of the as-a-Service market are trying to bring their offering to the next level all by themselves.  

A thorough due diligence process is required on an individual project basis with all potential risk takers (e.g., insurer) at the table. Only when risks are fully understood, ways of mitigations and transfers can be found. Ultimately, after mitigating risk as much as possible, it is the combination of placing risks with the best owner and adequately sharing remaining risks no stakeholder has appetite for within the ecosystem. 

A silver lining on the (market) horizon 

Integrating pay-per-use components in one’s offering provides early adopter advantages. If the risk structure can be designed adequately and all parties involved are prepared to work towards an acceptable solution, there are a few investors who are already prepared to take on an investment opportunity: A new asset class will evolve, composed of machinery assets, collateralized by flexible assets and receivables from users, offering an illiquidity premium presumably above the one incorporated in classical infrastructure investments. A new asset class which fuels productivity of manufacturers worldwide is emerging at the horizon – get in contact with us to be part of the journey. 

For more information get in touch

Daniel DietzConsultant Finance & Risk Transfer